The Energy Report: Stephane, do you think the oil price has hit bottom and is now recovering?
Stephane Foucaud: When the Brent oil price was close to $50/barrel ($50/bbl), I think it was the bottom. It has recovered quite a bit. There is a risk that it might dip again, but I don't think we will reach the low $50s for quite some time. The reason I think there is a risk that the oil price could dip is that there has been an overreaction to the North American rig fleet reports, and particularly to what appears to be a large number of rigs being taken out of the market. Those rigs are, however, associated with lower-producing areas. Therefore, I think it's more sentiment than reality in terms of impact on the supply. The recovery has been too steep.
TER: What prices are you forecasting for 2015 and 2016?
SF: For 2015, we are anticipating $59/bbl Brent. For Q1/15, we have $54/bbl; Q2/15 at $58/bbl; we expect to end up at $63/bbl. For next year, we have $72/bbl. The trend on the one-year view is upward, but with some fluctuation.
TER: The Islamic State of Iraq and Syria (ISIS) is growing in Libya, and is threatening the oil industry there. How would capture of the oil fields by ISIS affect commodity prices?
SF: Though it is part of the equation, and Libya is a problem, production in Libya has already dropped a lot, and is arguably already factored into the oil price. I think the situation in Iraq and Kurdistan with regard to ISIS is equally, if not more, important. If you have deterioration of the situation in Kurdistan and Iraq, that will have a positive impact on the oil price. Now, that has to be considered in the context of Venezuela potentially blowing up, which would be very serious, or Russia disappointing. And Russia is currently a black box.
TER: What do you mean by black box?
SF: There are currently sanctions on Russia. But I think most of the market does not really expect much decline in supply this year from Russia. Very few oil forecasting agencies have a detailed model as it applies to Russia, because there is very little visibility. So analysis is often focused on the U.S., and to the north in Canada, where there is a free flow of information and a lot of granularity. We don't have that level of detail on Russia.
"There is a risk that the oil price could dip because there has been an overreaction to the North American rig fleet reports."
Russia is one of the largest producers in the world. Any deviation from the broad assumption of production not dropping this year in Russia could be very meaningful.
TER: You have a four-tier strategy for investment, and you've slotted some of your companies into one tier or another. How do you evaluate where they should go?
SF: First, I look at whether a company remains fairly defensive, even in the current oil price environment, on the strip curve for Brent. I am cautious about companies with overall asset value being marginal on the strip curve for Brent, or with funding issues on the strip. Second, I look at whether a company is operating in an area where the risk profile is not too high, so there is not something that could suddenly blow up. Taking too much political risk in the current market needs to offer really material upside. Third, I look at the share price and see where I find value on the house view for Brent.
TER: How has the collapse in commodity prices affected the oil and gas companies you cover?
SF: First, their share prices have been hit extremely hard. Most companies have seen their share prices halved—and sometimes more than halved—but not all of them. The ones that are very well funded have been more defensive. Second, the fundamental values of the assets have gone down. Third, given the reduced cash flow, companies face issues with their balance sheets and the repayment of any debt.
So today it's about looking at companies that are able to survive in the current environment, and are still offering value on the strip. The companies we like in the current environment are those whose share prices have dropped much more than the underlying value of their assets, and those that are still funded.
"If you have deterioration of the situation in Kurdistan and Iraq, that will have a positive impact on the oil price."
Companies we like at the moment include Premier Oil Plc (PMO:LSE) and TransGlobe Energy Corp. (TGL:TSX; TGA:NASDAQ). Premier is a North Sea story, and the market is somewhat concerned with its debt. The company is embarking on a relatively low-risk exploration program in the Falklands. A success could attract a farm-in partner, which would be a rerating event as investors do not seem to ascribe much value to this group of assets. TransGlobe Energy is cheap, and arguably offers the benefit of being in an area where the politics are getting a bit better.
TER: How will TransGlobe Energy's writedown of its Yemeni assets affect the company?
SF: I think the writedown was broadly expected. The situation in Yemen is difficult and pretty complex. We are not fundamentally surprised that the company decided to write down its assets. The contribution to the company value compared to shareholder expectation is absolutely minimal.
TER: How has Premier Oil responded to the collapse in oil prices?
SF: Premier has kept its net debt almost at the same level. The net debt level has been higher than the current market cap for some time.
The fact that Premier explores in the North Sea means it is, by definition, quite sensitive to the oil price. At one point, the share price was half what it was before the oil price collapse. That's quite significant given that Premier is one of the blue-chip exploration and production companies listed in London, with good hedge in place on its production. The shares are also very liquid.
So it has been difficult. The value of the company has gone down because the oil price is lower and it has fairly high-cost assets. But, again, that's what you'd expect in a world where the oil price drops.
TER: Premier has described its hedging policy as "conservative." What does that mean in practice?
SF: It means that the oil price at which the company is hedged is quite high, and that a fairly important component of its production is being hedged. Particularly when you look at the lower oil price environment, the overall cash flow of the firm is enough—or close to being enough—for the company to operate with confidence.
"Any deviation from the broad assumption of production not dropping this year in Russia could be very meaningful."
For instance, if the indebtedness of a company is quite low, and if the costs associated with its assets are also quite low, one would argue that such a company would need less hedging than a company that needs a high oil price to make its assets work and to repay debt. By "conservative," Premier means it is quite resilient to a low oil price, and can deal with fairly high-cost assets and a high level of debt.
TER: Is there a last company you would like to mention?
SF: Our argument for Tethys Petroleum Ltd. (TPL:TSX; TPL:LSE) is based on growing production to China, increasing gas export price, and exploration upside in Tajikistan. But more than anything, it's all about the completion of the deal with a Chinese private equity firm that would be buying 50% of Tethys' Kazakh asset. The value of this deal is more than Tethys' current market cap. At the time that this deal closes, the company gets over US$80 million (US$80M), which compares with a market cap at the moment of less than £30M (about US$45M). You can see the investment logic. This is almost 50% upside on the transaction with the Chinese private equity firm. Beyond that, there is production growth and exploration upside in Tajikistan. The upside is quite significant.
TER: How are you advising investors to proceed in the oil and gas space now, given current prices?
SF: Look for names that offer liquidity. Look at the value of a firm based on the future curve for the oil price, and look for companies that have value at that level. If the oil price gets better then great, there will be some upside. Our approach is quite cautious—liquidity, value on the strip, upside beyond the strip, and the relative assurance that there won't be a serious debt issue in the near term.
TER: Thank you very much for your time, Stephane.
Stephane Foucaud is managing director, institutional research, of FirstEnergy Capital LLP. Before joining FirstEnergy, he was head of oil and gas research at Fox Davies Capital and senior oil and gas analyst at Société Générale in London, covering Royal Dutch Shell, BP, BG Group, Statoil and Cairn Energy. Foucaud also worked for Schlumberger for seven years in various technical, operational management and corporate strategy roles. He holds a master's degree in engineering from the National School of Electrical and Mechanical Engineering of Nancy, France, a master's degree in exploration production from the French Petroleum Institute, and a master's degree in business administration from INSEAD in France.
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